By Tim Courtney, Chief Investment Officer
As of this Thursday, broad U.S. stocks were down 17% YTD with small-cap and growth stocks already in a bear market, having fallen more than 20%.1 This has followed a bull market from March of 2020 through the end of last year in which broad global equity markets rose between 70% and 140%.2 Those who stayed in markets during that time captured those returns. But when markets get choppy, the question often becomes, can I pocket the good returns but sidestep losses?
You could pick any number of reasons to avoid investing in markets today: war, inflation, interest rates, supply chain constraints and a host of other variables. However, other investors see the same things we see in the world, so does it make sense for us to sell assets to them after a downturn in the hopes of avoiding additional losses?
Our experience and conclusions in several studies demonstrate this is difficult or close to impossible without reducing our expected returns and outcomes.
1. When to exit. Stock market dips are not uncommon: downturns of 5% happen multiple times per year. Corrections are rarer but still happen about once every year to year and a half while bear markets have occurred about once every 6 to 7 years. So when we experience a market drop, there have been lower odds that it will continue to grow into a larger decline. This means it is unclear which downturns to ignore and which ones to act upon to avoid a potential larger decline. There were valid concerns investors could have pointed to during every past market correction but exiting during these would mean exiting and entering markets fairly frequently. This would be closer to speculating than investing.
2. Headlines. The news of the day certainly moves markets. That said, current events, risks and opportunities are often already reflected in market pricing since we all have access to this information. It is certainly possible the market could be understating a particular risk in the world, which happened during the mortgage bond market collapse of 2008.3 But successfully betting markets haven’t incorporated risk properly, and doing it consistently has been difficult, even for those that did correctly see problems in 2008.
3. Acting fast. Probably the biggest challenge to successfully timing moves in and out of markets is the need for speed. It is true that if you are fortunate enough to avoid most of a 40%+ downturn you will likely have some time to get back into markets before your savings are eroded by a recovery. But these are rare with only 5 occurring in the last century, two of which happened during the Depression.4 For smaller downturns, speed is critical.
As you can see above, consistently dodging part of a downturn and getting back in before the market eliminates your savings is difficult because the moves higher can happen quickly. This study shows that you have months, and many times only a few weeks, to make a reentry decision. These timing strategies of exiting at a certain point in the decline and reentering months later had lower returns than buy and hold strategies.
We’ve reviewed timing strategies many times and found them unworkable without the benefit of hindsight. We’ve found that a timing strategy that ends up invested in stocks 80% of the time and holding cash or bonds 20% of the time most often has similar performance to a consistent allocation of 80% stocks and 20% bonds minus trading costs/taxes.
Risks are always present and, of course, they are abundant today – this is where stock return premiums come from. Risk and return are still related and, as the study above shows, avoiding risks usually means reducing outcomes and returns. If you have any questions about this or how risks should be managed in your accounts please contact your Exencial advisor.
Performance shown is hypothetical and for illustrative purposes only. The performance was achieved with the retroactive application of a model designed with the benefit of hindsight; it does not represent actual performance, and it does not take into account any individual investor circumstances. Hypothetical performance does not reflect trading in an actual portfolio and may not reflect the impact that economic and market factors may have had on trading decisions.
Market represented by Fama/French Total US Market Research Index. Downturns are defined as the first instance of a cumulative return meeting the –10%, –20%, or –30% threshold following a day when the index has reached a new all-time high level. Timing strategies switch from the US stock market (represented by the Fama/French Total US Market Research Index) to One-Month US Treasury Bills (represented by the IA SBBI US 30 Day TBill TR USD provided by Ibbotson Associates via Morningstar Direct) following each downturn and switch back to the market following the number of trading days denoted. Past performance is not a guarantee of future results. No costs included.
The Fama/French Total US Market Research Index is made up of US companies included in the CRSP (Center for Research in Security Prices) database going back to 1926. The index includes large, mid-cap and small companies and is market cap weighted. It is maintained and directed by the research teams of Ken French at Dartmouth and Eugene Fama at the University of Chicago.
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.